Confounding Factors for Technical Analysis
One thing I've been struck by technical analysis in stock trading is the attempt to distill something as complex as the combined actions of millions of market participants into easy to handle formulas and mathematical models. This is the history of economics played out again - trying to find 'the right formula' that will explain it all. I think Nassim Taleb does a wonderful job of destroying the idea that there's a single economist on the planet who can forecast out more than a few years, or past the next unexpected event.
I understand that at its best, TA is a way to generate probability-based bets, under the assumption that you'll be right just enough more than you're wrong and make money. I think it's hard to avoid the trap of getting overly confident in these signals, the spike in the SP500 a few days ago is a pretty ringing example.
One of the most popular forms of analysis I've found, especially lately, is to compare the market to past bear markets, and try judge which past pattern it will fit. Tempting, for sure, but isn't it fundamentally flawed? To some degree people haven't changed much in 100 years, but there are many things that have changed that affect the way markets behave. It's these confounding factors I'd like to discuss.
1. One major difference is the technical knowledge of market participants. Almost everyone who invests money now has at least a rudimentary understanding of TA concepts, moving averages, fibbo retracements, etc. Certainly everyone near a trading desk is well aware of even more complicated stuff like Elliot waves and such. I think this has to have an affect on the way the market behaves... to me it seems to move more violently after a technical indicator is breached, and seems to waver a lot when near major support/resistance levels. Lots of people can get fooled when a more obvious technical indicator is wrong, like the spike in the SP500 last Wednesday.
2. The prevalence of automated trading platforms, trailing stops, and other trading tools. Any shmoe can get a think or swim account and have access to complex trades that weren't possible not too long ago, and hedge funds/brokers have computer-driven trading algorithms that make their own trading decisions. We've seen huge moves in the last 30 or even 10 minutes of the trading day thanks to all those computer traders moving in unison.
3. Which brings me to education - most traders (and economists for that matter) share a disturbing groupthink pattern. They are all educated the same way, with the same theories, and as a result tend to reach the same conclusions at the same time. This, I think, is responsible for a good % of the sickening volatility the market has had since summer 07.
4. The rise of mutual funds driving the market. Not too long ago, a much larger % of the market was directly controlled by individual investors. Now their presence is almost nothing more than margin of error. The entire market is driven by a tiny group of fund managers controlling shitloads of dough, and who reflect points 2 & 3.
5. Speed of info transmission. Never in our history has information traveled so fast. Rumors spawned via crackberry move markets in seconds and in major ways. I think this also contributes to volatility, as there is massive mental pressure to decide which way to bet within seconds of some new piece of news, and/or people are much more likely to follow a blip up or down if it happens at the right time.
6. The global pool of wealth. There's just shitloads of money out there that needs investing. Our tax policies don't exactly punish investors and reward entrepreneurs, so there's little reason to take one's money anywhere else than the markets. Why sweat and work starting a business when you can kick back and earn shitloads through tax-free munis? Add to that the US-fueled kings, princes and Chinese rulers who are sitting on metric ASSTONS of us$, who couldn't give a fuck about their dying and ignorant people, and would rather have even more money. If these unbelievable fucktards were to invest in their shitty states, they wouldn't have had so much to invest, which was one of the major underlying causes of the housing bubble. No matter how many shitty CDOs Godlman came up with, there was an unending line of folks wanting to buy more. That's called demand.
7. The corporatization of America. There used to be many independent newspapers in NY, now there are none of any note. Instead of a company started by a newsman and ran for journalism, all major news & media outlets are now nothing more than profit centers for massive trans-global corporations, who couldn't give a fuck what country they started out in. Even Google gets 60% of its revenues overseas, and most of HP's workforce isn't in America. This article has some great examples of how this is affecting the information that most people use to make their investing decisions:
http://www.minyanville.com/articles/inde....
Not to get too tinfoiled, but I don't believe there is any other rational way to view things. Media outlets who are subsidiaries of a company will serve that company's interests first. Duh.
8. The endless corruption at the highest levels. Justice seems to work like a pendulum, and we're about as far down the shitty side as I think it's possible to get without the common folk rising up in violent revolt (which may still happen). Bernanke issuing a surprise rate cut the morning before options expiration, the endless bullshit Karl has been pointing out for years... This probably affects the market more than anything else. Not only is it impossible to know where and how much the corruption is having an effect, but now all market participants are well aware of it. So people now trade like the market is rigged, which is only going to bring on more unforeseen consequences (at the least, more volatility and a higher likelihood of people saying 'fuck this' and buying t-bills).
9. The act of observing affects the observed. Few things are more dangerous than trying to apply quantum physics to the real world, but this is a definite human phenomenon. In practical terms, to me it seems like a game of paper/rock/scissors. Everyone is expecting a bad GDP report so the market tanks, and it comes out and it's bad, but not as bad as it could be, so the market rallies. The next time people are expecting this, and for some reason the market tanks instead in the same situation.
I personally believe there are enough factors that are unique in the history of our markets that we will find it behaving in ways that don't fit any historical pattern. I fully expect that in 5 years, when someone posts those charts of bear markets against this one, that it won't look like the others. If only I could figure out how, I'd be out making cash instead of posting on the internets.
I understand that at its best, TA is a way to generate probability-based bets, under the assumption that you'll be right just enough more than you're wrong and make money. I think it's hard to avoid the trap of getting overly confident in these signals, the spike in the SP500 a few days ago is a pretty ringing example.
One of the most popular forms of analysis I've found, especially lately, is to compare the market to past bear markets, and try judge which past pattern it will fit. Tempting, for sure, but isn't it fundamentally flawed? To some degree people haven't changed much in 100 years, but there are many things that have changed that affect the way markets behave. It's these confounding factors I'd like to discuss.
1. One major difference is the technical knowledge of market participants. Almost everyone who invests money now has at least a rudimentary understanding of TA concepts, moving averages, fibbo retracements, etc. Certainly everyone near a trading desk is well aware of even more complicated stuff like Elliot waves and such. I think this has to have an affect on the way the market behaves... to me it seems to move more violently after a technical indicator is breached, and seems to waver a lot when near major support/resistance levels. Lots of people can get fooled when a more obvious technical indicator is wrong, like the spike in the SP500 last Wednesday.
2. The prevalence of automated trading platforms, trailing stops, and other trading tools. Any shmoe can get a think or swim account and have access to complex trades that weren't possible not too long ago, and hedge funds/brokers have computer-driven trading algorithms that make their own trading decisions. We've seen huge moves in the last 30 or even 10 minutes of the trading day thanks to all those computer traders moving in unison.
3. Which brings me to education - most traders (and economists for that matter) share a disturbing groupthink pattern. They are all educated the same way, with the same theories, and as a result tend to reach the same conclusions at the same time. This, I think, is responsible for a good % of the sickening volatility the market has had since summer 07.
4. The rise of mutual funds driving the market. Not too long ago, a much larger % of the market was directly controlled by individual investors. Now their presence is almost nothing more than margin of error. The entire market is driven by a tiny group of fund managers controlling shitloads of dough, and who reflect points 2 & 3.
5. Speed of info transmission. Never in our history has information traveled so fast. Rumors spawned via crackberry move markets in seconds and in major ways. I think this also contributes to volatility, as there is massive mental pressure to decide which way to bet within seconds of some new piece of news, and/or people are much more likely to follow a blip up or down if it happens at the right time.
6. The global pool of wealth. There's just shitloads of money out there that needs investing. Our tax policies don't exactly punish investors and reward entrepreneurs, so there's little reason to take one's money anywhere else than the markets. Why sweat and work starting a business when you can kick back and earn shitloads through tax-free munis? Add to that the US-fueled kings, princes and Chinese rulers who are sitting on metric ASSTONS of us$, who couldn't give a fuck about their dying and ignorant people, and would rather have even more money. If these unbelievable fucktards were to invest in their shitty states, they wouldn't have had so much to invest, which was one of the major underlying causes of the housing bubble. No matter how many shitty CDOs Godlman came up with, there was an unending line of folks wanting to buy more. That's called demand.
7. The corporatization of America. There used to be many independent newspapers in NY, now there are none of any note. Instead of a company started by a newsman and ran for journalism, all major news & media outlets are now nothing more than profit centers for massive trans-global corporations, who couldn't give a fuck what country they started out in. Even Google gets 60% of its revenues overseas, and most of HP's workforce isn't in America. This article has some great examples of how this is affecting the information that most people use to make their investing decisions:
http://www.minyanville.com/articles/inde....
Not to get too tinfoiled, but I don't believe there is any other rational way to view things. Media outlets who are subsidiaries of a company will serve that company's interests first. Duh.
8. The endless corruption at the highest levels. Justice seems to work like a pendulum, and we're about as far down the shitty side as I think it's possible to get without the common folk rising up in violent revolt (which may still happen). Bernanke issuing a surprise rate cut the morning before options expiration, the endless bullshit Karl has been pointing out for years... This probably affects the market more than anything else. Not only is it impossible to know where and how much the corruption is having an effect, but now all market participants are well aware of it. So people now trade like the market is rigged, which is only going to bring on more unforeseen consequences (at the least, more volatility and a higher likelihood of people saying 'fuck this' and buying t-bills).
9. The act of observing affects the observed. Few things are more dangerous than trying to apply quantum physics to the real world, but this is a definite human phenomenon. In practical terms, to me it seems like a game of paper/rock/scissors. Everyone is expecting a bad GDP report so the market tanks, and it comes out and it's bad, but not as bad as it could be, so the market rallies. The next time people are expecting this, and for some reason the market tanks instead in the same situation.
I personally believe there are enough factors that are unique in the history of our markets that we will find it behaving in ways that don't fit any historical pattern. I fully expect that in 5 years, when someone posts those charts of bear markets against this one, that it won't look like the others. If only I could figure out how, I'd be out making cash instead of posting on the internets.
posted by Dave Rants at
11:22 PM
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